Common Valuation Mistakes 2 - ISyE 4106 Senior Design...

1 ISyE 4106 Senior Design Common Project Valuation Mistakes After reading all of the pre-proposals, I realized that almost every team made one of a few common mistakes when trying to estimate the value of their project. So, in order to help you avoid making those mistakes in the future, here is a short list of helpful hints and examples. 1. If it sounds too good to be true, it probably is. It’s rare that companies do extremely stupid things or miss obvious, simple solutions. So, if it looks like you can save your company’s problems by doing something patently obvious, look more closely – it might be that you’ve missed something, or perhaps the company has forgotten to mention an important aspect of the problem. Example 1A : “On average, workers pick ten orders per day. The expected cost of picking each additional order is $5, and the benefit is an increased revenue of $505 per order picked. Therefore, by streamlining the order-picking system so that 3000 additional orders can be picked per year, we provided a value of ($505/order − $5/order) × 3000 orders/year = $1,500,000/year.” Problem : If there’s such a big benefit to picking extra orders, why hasn’t the company just hired another worker or two, or add an extra shift on some days? Solution : It’s not clear what’s missing from this analysis, but there’s something that hasn’t been accounted for. Ask your company contact what’s missing (or, if they say nothing is missing, find out what’s stopping them from just hiring an extra worker and reaping a million-dollar benefit). Example 1B : “The extra machine would cost $1,000,000 to purchase, and would allow the company to make 1000 more units per year. With an average revenue per unit of $8000, the overall value would be 1000 units/year × $8000/unit = $8,000,000/year, and the machine’s payback period would be less than two months.” Problem : If every extra machine yields $7,000,000 profit in the first year alone, why didn’t they think of buying one (or even more than one)? Or, why didn’t they just run the machines they had for an additional shift?) Solution : Again it’s not clear what’s missing (but see Examples 2B and 3A for some possibilities), so ask your company contact why they didn’t just buy a new machine on their own.

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2 2. The true value of a change is often deeper than a simple calculation. Changes often have “ripple effects” that induce other changes. On the other hand, sometimes making a change has less direct effect than it originally seems. It’s important to consider all the potential ramifications (and limitations) of a change. Example 2A

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